THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.

FAREED ZAKARIA, HOST: This is GPS, the GLOBAL PUBLIC SQUARE. Welcome to all of you in the United States and around the world. I'm Fareed Zakaria.

This has been another week of outrage over Wall Street. But mixed in with the outrage, there continues to be a bewilderment about how these problems in the financial industry could have been piling up without warning.

When being briefed by academics from the London School of Economics, Queen Elizabeth II asked a simple question: Why did nobody notice it?

In fact, some people did notice it. Warren Buffett, Paul Volcker and others did warn about the danger of derivatives and debt. Others warned about Fannie Mae and Freddie Mac.

But through all these warnings, the markets kept rising. Financial firms minted money. The naysayers looked like fuddy- duddies, and the risk-takers like geniuses. No one likes to fight success.

Actually, there was one guy who took on the financial firms at the height of their prestige and power when the country, the media and Washington were gushing with admiration.

That man was Eliot Spitzer.

And he is my guest today, for his first interview since resigning as governor of New York.

You remember him as the governor of New York who resigned after a scandal involving prostitution. But think back before then. He was the attorney general of New York who went after Merrill Lynch, prosecuted AIG and several other institutions for practices he argued were corrupt, fraudulent and illegal. Those prosecutions were deeply controversial, and Spitzer made most of Wall Street his enemy.

I'm going to talk to him about what he thinks about the world he's watching today.

Also on GPS, we're going to have a distinguished panel talk about populism. Has it gone too far? And an exclusive interview with Bill and Melinda Gates on the key to America's recovery and success.

So, stay with us. (BREAK)

ZAKARIA: So, now to my guest today, former governor of New York, former attorney general of New York, Eliot Spitzer.

Welcome.

ELIOT SPITZER, FORMER GOVERNOR OF NEW YORK: Thank you. A pleasure to be here.

ZAKARIA: When you saw the news about these AIG bonuses, what did you think? This was the company that you prosecuted way back when.

SPITZER: On the one hand, I was not surprised. Bonuses are part and parcel of Wall Street compensation. And I think if you looked at any company, you would see bonuses of an equivalent size.

So I think to a certain extent, what we are now doing is looking at what is a typical part of Wall Street compensation, voicing a visceral outrage that is legitimate, but is not particular to AIG.

ZAKARIA: But when you took on AIG, what troubled you about it? What made you look at AIG and say something's wrong here?

SPITZER: Their fundamental accounting structure was wrong. And when we prosecuted them, we brought a case alleging that they had manufactured false, fictitious reinsurance contracts. It's a very technical issue, but there were false reinsurance contracts designed to create the appearance of capital on the books, which was not there. And this was a structure that had been designed and orchestrated at the very top of the company.

And as we dug into the accounting...

ZAKARIA: So, they were basically fudging the numbers to make it seem as though they had a stronger balance sheet than they had.

SPITZER: Precisely. That's exactly right.

And the underlying effort was to create an illusion of financial strength that was not there. And as we dug more deeply into the underlying structure and organization and accounting that was ongoing at the company, we knew there was a problem.

And just parenthetically, four people have been convicted of this. The former CEO was called an unindicted co-conspirator in the federal courtroom by the federal prosecutor. So, this was a fundamental effort to alter the actuality and to lie to the public.

ZAKARIA: So, do you think that the problems that AIG got into later on stem from some of the same practices that you were trying to get at?

SPITZER: They stemmed from an effort from the very top to gin up returns whenever, wherever possible, and to push the boundaries in a way that would garner returns almost regardless of risk. And so, to the extent that there is a discussion, did this begin before or after the tenure of Hank Greenberg, it's unambiguous -- unambiguous that the structures and the flaws and the policies began while he was there. That is why the board that he had controlled with an iron fist asked him to leave. It was their decision -- not my decision, their decision -- to ask him to step down, something that was then and is now very unusual.

He has invoked the Fifth Amendment, which, of course, is his right to do. But he was asked to leave by his own board, because they saw the flaws and the problems that have since multiplied and created this monster that can bring down the financial system.

Back then I said to people, AIG is at the center of the web. The financial tentacles of this company stretched to every major investment bank. The web between AIG and Goldman Sachs is something that should be pursued.

And as I have written...

ZAKARIA: Meaning what? Meaning that a lot of the money that we the taxpayers gave AIG has ended up being paid to Goldman Sachs...

SPITZER: Precisely. And...

ZAKARIA: ... and other companies.

SPITZER: The so-called counterparties to these very sophisticated financial transactions.

When AIG initially received $80 billion -- a decision that was the consequence of a very brief meeting of the president of the New York Fed, the secretary of the Treasury, perhaps Chairman Bernanke and arguably, some reports say, the chairman of Goldman Sachs -- $80 billion, virtually all of it flowed out to counterparties, $12.9 billion to Goldman Sachs.

Why did that happen? What questions were asked? Why did we need to pay 100 cents on the dollar on those transactions, if we had to pay anything? What would have happened to the financial system, had it not been paid?

These are the questions that should be pursued. Look, bonus is a real issue. It touches us viscerally. The real money and the real structural issue is the dynamic between AIG and the counterparties.

ZAKARIA: Because those payments are in the tens of billions of dollars. The bonuses are a few hundred million.

SPITZER: The bonuses we think are $164 million, give or take -- huge money. I mean, nobody should diminish that. These counterparty payments, tens and tens of billions of dollars.

ZAKARIA: And it, to your mind, it seems as though this taxpayer money may have been recklessly and unwisely paid off?

SPITZER: Well, it may be that a case could be made that it should have been paid.

But at a moment in our nation's history when everybody is being asked to bear a piece of the burden -- everybody -- people are being told work four days a week, not five. Sales taxes are going to go up. Contracts are being broken and renegotiated for workers across America. Our 401(k)s and our savings have been depleted by the recklessness of Wall Street.

For Goldman and the other counterparties not to be able to say, we can make do with only 50 cents on the dollar, 30 cents on the dollar, after we've already given Goldman a $25 billion cash infusion, they are sitting on vast amounts of cash on the sidelines -- which is their right, but they're going to invest it in due course, based upon their judgment -- for them, on top of all that to get another $12.9 billion in the dark without questions, after a meeting of this sort, is fundamentally wrong. And that is the nature of the inquiry that should be raised.

ZAKARIA: Is there, as far as you know, a congressional inquiry into these monies?

SPITZER: I do not know if there is or isn't. I certainly hope that Barney Frank, who is the chairman of the right committee, will do so. He's a brilliant guy, a spectacular legislator and lawyer. I have absolute confidence that if he pokes at this, he will get to the bottom of it.

He is somebody -- there are many on Capitol Hill who are beating their chests so loudly, you know it's just a cover-up of their neglect and failure over the last decade. They sat there and watched and did nothing, as they clearly should have known that we were building a system that was a house of cards. And they enjoyed it and prospered from it, and there was a symbiotic relationship between them and Wall Street.

Barney Frank is not one of those. Barney Frank will ask the right questions, and I hope he does.

ZAKARIA: Was the regulation -- was the regulatory regime in place strong enough? And I'm thinking particularly of the New York Fed, which was headed by Tim Geithner, of the SEC?

Where do you see the flaw having been over the last few years?

SPITZER: Here's my answer to that. The regulatory system was structurally flawed, but that's not why this happened.

After the last round of scandals -- Enron, et al. -- we passed Sarbanes-Oxley. And we said, aha, we've solved the problem. Now we have another set of scandals.

There are enough laws, enough regulations on the books for smart, aggressive regulators and prosecutors to make all the cases. What was missing was judgment. And you can't legislate judgment. You can't regulate judgment. Either the people who are the regulators will walk into a bank and say "Your leverage is too great. We are going to take actions to pull it back," or "This type of investment is flawed," or they won't. You can't pass a law that says, you must use sound judgment.

Bubbles have been there through history, through over-regulation and under-regulation. This is a question of judgment and of failure of judgment.

When I was attorney general, people said, "Oh, you're using this crazy little statute," the Martin Act in New York, "to bring all these cases." The Martin Act had a simple anti-fraud provision. That's all we used.

The federal government has exponentially more regulatory power than we did. What was lacking was the judgment, the tenacity, the desire to rein in a financial system that was spiraling out of control.

ZAKARIA: How do you think President Obama is handling this crisis?

SPITZER: Well, I think he is doing stupendously. I mean, I'm a huge fan of his. I think we all have to be and should be, if only because he has been thrust into a dynamic that is almost impossible.

He is trying to put out not 500 small fires, 500 forest fires simultaneously. And he is addressing them sequentially, trying to keep a political coalition together. But it's very hard.

And I think one of the largest, most difficult tasks that he has is to control the outrage that is brewing in the public -- sympathize with it and garner it, but use it to get good policy, not policy based upon anger.

Populism, if we go to the other extreme -- and we had libertarianism masquerading as capitalism for the past 30 years. That didn't work. And we knew it wouldn't work.

I'm worried that we will go to the other extreme and end up with rank populism. That could be just as dangerous.

And it's very hard to craft the reasoned policies that make the market work without losing the support of the public. That's what he's trying to do. It's a very difficult task.

He is a brilliant communicator and a brilliant leader, and I think we all have to hope that he succeeds.

ZAKARIA: Do you worry about this kind of populist anger when you watch the outrage over the bonuses?

SPITZER: Yes, yes. The outrage is legitimate, but it is being fomented by sort of a faux populism by many on Capitol Hill who saw this coming, who knew this was going on. And so, I look at them and I say, "Come on, guys. You're supposed to be more mature. Express the anger, but then say, how do we solve it? Don't just throw more oil on the fire."

And I am worried about that. And I'm worried that it will be destructive to our capitalist system. And I've said since the very beginning, that my energy was directed at preserving and protecting capitalism.

The libertarians didn't understand it. Populists don't understand it. But capitalism is what we want to preserve.

ZAKARIA: A simple legal question. If you were in a position where you could do something about it, what would you do about the bonuses? Legally, what strategy would you employ?

SPITZER: I think I might go back to a very old tort theory of unjust enrichment -- contract theory, tort theory -- and say, you know what, guys? There's a theory in the law that says -- a couple of theories -- one impossibility saying, AIG just doesn't have the money to pay you. And absent the federal infusion, it wouldn't have it, so we can't pay.

And second I would say, unjust enrichment. You simply don't deserve it. It's an equitable argument. Some courts might go for it, some courts might not.

But as a practical matter, as the president of the United States, I think I would call the CEOs into the Oval Office. And I would say, "Guys, this is untenable. We're all going to have to suck it up a little bit and show the American people that we know what it means to be part of a community, and share the sacrifice. Let's see if we can't solve this without the legal wrangling."

And I bet he could. I have no doubt that President Obama could do that.

ZAKARIA: And we will be back with Eliot Spitzer right after this.

(BEGIN VIDEO CLIP)

ZAKARIA: You know there are a number of people watching who are going to say, Eliot Spitzer doesn't have credibility to talk about these issues, because of what happened over the last year with your own behavior.

(END VIDEO CLIP)

(COMMERCIAL BREAK)

ZAKARIA: And we are back with Eliot Spitzer.

Eliot, you've spent a lot of time looking at Wall Street, battling with them often. What do you think is the fundamental thing that got us into this mess? SPITZER: Recklessness, greed and a misunderstanding of what capitalism is all about, and a belief that financial services alone could generate wealth.

Financial services doesn't really generate wealth. Financial -- the capital markets are designed to raise money and then apportion it to industries that are creative, whether it's biotech or automotive, or anything else.

Financial services should be a conduit. Instead, we became enamored of the products themselves. And what resulted was this enormous bubble in assets, ginned up and supported by a financial services sector that, because of a series of improper incentives, got us to where we are right now.

ZAKARIA: And what should have been done? Should there just have been a lot more attorneys general like you kind of battling this?

SPITZER: We had one who was enough, I thought. But it was...

ZAKARIA: But should there have been a different kind of regulation? How should this have been prevented?

SPITZER: There should have been a very different regulatory framework. Not in the sense that we needed more words in the books. We needed more aggressive voices at the SEC, the FTC, the OCC -- this welter of federal agencies -- people who came to Wall Street and said, "Wait a minute. That leverage is crazy."

And it was -- it's kind of odd, because everybody derided leverage in public, but in private, participated to the hilt. And when you look back at these deals you say, this was crazy. We needed regulators who said it. We needed wiser voices on Wall Street.

This was sort of a disease that got into the bloodstream and the DNA of Wall Street leadership.

Now, there were some who were spectacular who disagreed with it, who said, "Wait a minute, guys. We can't afford this."

The more traditional, old-fashioned investment bankers -- you think of Felix Rohatyn, who said, "Wait a minute, guys. This doesn't work." And...

ZAKARIA: Right, right. Or Warren Buffett or Paul Volcker...

SPITZER: Or Warren Buffett. Well, I love Warren Buffett. We all do. He also invested in some of these vehicles that had the leverage, but I think he always was a voice of modulation.

And we needed more of that and, frankly, less of the sort of, you know, hotdog, cowboy mentality that leveraged everything up, sent it out so that people would structure deals without retaining any of the ownership.

If you want a technical answer, all of the securitization that was done, where you had the rating agencies, you had the originators who would originate loans they knew were bad, securitize them, get AAA ratings, securitize it out into a market -- they didn't maintain any ownership.

So, a simple rule could be, if you securitize a stream of debt, you've got to retain 10, 15, 20 percent, so you are at risk. You evaluate deals very differently if you are actually at risk, rather than merely selling it to somebody else.

ZAKARIA: And that could have been part of the regulation.

SPITZER: Absolutely. The power of the federal agencies to do this stuff was unlimited.

And any time I hear the SEC say, we didn't have the power to do this or that, forget it. They had more people, more power, more money than was necessary. What they lacked was the creativity and the will.

ZAKARIA: In a sense, this is almost a greater failure of Washington than Wall Street.

SPITZER: Well, there have been debates -- Washington, Wall Street. It's one of those debates where, of course, both were at fault.

Now, I happen, having been on the government side, to have a slightly more aggressive view of what government should do, perhaps. And I believe that Wall Street was at fault for fostering an ideology, and imposing an ideology, or buying its way into an ideology in Washington that said, "Let us alone. We will self-regulate."

So, Wall Street created this notion of self-regulation, sold it to Washington with all of its tremendous capacity through fund raising and intellectual capital. Washington was happy enough to succumb to the temptation.

Self-regulation was a mirage. It was an abject failure. Some of us were saying, it always will be a failure.

So, Wall Street is to be blamed for creating the notion, Washington is to be blamed for buying into it. Who's more at fault is sort of a puerile debate, but I think both parties.

ZAKARIA: What about the media, CNBC? You actually know Jim Cramer. You know all the parties involved.

SPITZER: Full disclosure. Jim is a great and close friend. And I think he took his licks from Jon Stewart last week. And Jim said on the show, "Yes, we have to have done better."

And I think the media -- writ large. I mean, forget CNBC. I think the entire media -- print media, TV media, et cetera -- did not ask the hard questions as these deals were being structured, as the bubble was inflating.

We turned the Wall Street masters of the universe into these icons, who bestrode the universe and made no mistakes, when I think a more inquisitive attitude would have said, "Wait a minute, guys. This won't last."

And so, I think, yes.

We're all at fault, which is why the search for villains is emotionally satisfying, not terribly useful. The better effort is, OK, what do we learn? What do we do going forward?

ZAKARIA: Now, a lot of people look at your prosecutions, and they say, "Look. This was very unfair, very selective. You would threaten these companies, therefore plunging their stock price. In many cases you didn't get convictions. If this is the model, it's not going to work. It's unfair."

SPITZER: Well, I think they're wrong, needless to say. But I think if you look at the cases, the analyst cases where we highlighted -- you referred to the Merrill Lynch case where, at the end, we got Merrill, Goldman, Bank of America -- all the major firms, all of the bulge-bracket firms -- to agree to an entirely new structure of doing analytical work, which was necessary for the integrity of the marketplace.

Whether it was insurance, mutual funds, analytical work, on and on, each of the major areas we looked at, we sought to craft a solution.

ZAKARIA: But your real leverage was that, once you go out in the public, their share price starts dropping and...

SPITZER: No question about it. And I'll give you a real example of that, and you can evaluate it as you wish, with Merrill Lynch.

They wanted us to settle. They would have paid some money. But they said, you must keep all the evidence secret."

And I said, no, my job as a public prosecutor is to explain to the public what the problems are in Wall Street. I said, that is the only way we will get a remedy. And I said, we must present this to the public. It may be right, it may be wrong.

And we didn't do this to hurt individuals. And we took out the names of most of the individuals. But we said, the public has to understand why the market is flawed.

And I think it's fair to say we, several years ahead of time, were saying, be careful, beware of what is going on here. I'm not pretending to see everything. I'm not pretending to be smarter or better than anybody else, just saying, wait a minute. We have seen a problem that, if not addressed, will be the downfall of the market.

ZAKARIA: But you got very few convictions.

SPITZER: No, we -- well, first of all, most of the cases were civil cases. And there was a reason for that. I did not believe in taking one individual and making him the subject of all the venom. I said, this is a civil issue. Resolve it with the company.

I tried very hard not to vilify individuals, because it wasn't a mid-level executive who was the problem. It was the whole structure. And that's why the global deal was with all the banks.

We didn't say to individual X, you're the problem. That's a mirage. That is an emotional, as I said, an emotionally satisfying effort, but it would not have solved the problem.

ZAKARIA: And we will be back with Eliot Spitzer right after this.

(BEGIN VIDEO CLIP)

SPITZER: I never held myself out as being anything other than human. I have flaws, as we all do, arguably. I failed in a very important way in my personal life, and I have paid a price for that.

(END VIDEO CLIP)

(COMMERCIAL BREAK)

ZAKARIA: And we are back with Eliot Spitzer.

You know, there are a number of people watching who are going to say, Eliot Spitzer doesn't have credibility to talk about these issues, because of what happened over the last year with your own behavior.

What would you say to them?

SPITZER: I would say to them that I never held myself out as being anything other than human. I have flaws, as we all do, arguably. I failed in a very important way in my personal life, and I have paid a price for that.

I have spent a year with my family, with my wonderful and amazing and forgiving wife and three daughters, and have rebuilt those relationships, and hope to do that as time goes on.

I also feel that, to the extent, if I'm asked, and I can contribute to a very important conversation, I will do that as well. That is our right, arguably our obligation as citizens. I will do what I can, and with full awareness and heaviness of heart about what I did.

ZAKARIA: But it wasn't just a personal failing. There were also legal issues involved...

SPITZER: Well, those were not pursued by those who decided to pursue them.

But I have made no excuses. I have not shirked, and I will not do so. I failed. I resigned my position, because I said this is the appropriate step for me to take.

ZAKARIA: Do you feel like you wish, watching all this, you were back in office doing something about it?

SPITZER: Well, obviously, I, first and foremost, hope that we can solve the problems, because the future of our economy -- and without overstating it, our nation -- is at stake here. If I can contribute, I will do so in whatever way I can.

Obviously, I care deeply about these issues. They were central to what I did as attorney general. And so, I read the papers and say, sure, these are issues that I feel deeply about. But I am where I am, because of my own conduct. And as I said, I make no excuses.

ZAKARIA: Do you imagine you could ever be back in government?

SPITZER: I don't think about it. I don't worry about it. I focus on a family, on the issues. If I write an occasional column and speak occasionally, that is all I'm doing.

ZAKARIA: Eliot Spitzer, thank you for coming on.

SPITZER: Thank you.

ZAKARIA: And we will be back.

(BEGIN VIDEO CLIP)

BILL GATES: Well, the whole world would suffer if the U.S. isn't at the cutting edge.

(END VIDEO CLIP)

(COMMERCIAL BREAK)

ZAKARIA: So, the populist rage against these million-dollar bonuses and the companies that give them -- has it all gone too far?

I brought together three sharp thinkers, all of whom once worked on Wall Street to talk about this.

Megan McArdle writes an economics blog for the "Atlantic Monthly," and she has worked in technology, consulting and finance.

Roy Smith was a partner at Goldman Sachs and is now a professor at NYU. He caused quite a stir last month when the "Wall Street Journal" published his editorial defending Wall Street bonuses, titling it, "Greed Is Good."

(LAUGHTER)

As an analyst, Henry Blodget was seen as the oracle of the Internet boom at Merrill Lynch, but was forced out from the industry amid allegations of fraud -- which came, by the way, from Eliot Spitzer. Now proving that there are second acts, he has returned to his first career, journalism, with a blog called "Silicon Alley Insider."

Welcome to all of you. Roy, let me ask you, do you want to defend the bonuses at AIG?

ROY SMITH, STERN BUSINESS SCHOOL, NEW YORK UNIVERSITY, FORMER PARTNER, GOLDMAN SACHS: Well, I'm not that crazy, to stick my neck into that lion's mouth.

ZAKARIA: But you can understand. The average taxpayer makes $45,000 a year. He feels this company would have been bankrupt, if not for the taxpayer infusion of funds.

You know, no matter how well they were doing their job, the whole company would have collapsed. There would have been no employment, let alone bonuses, if the taxpayer hadn't bailed them out. And these guys are getting bonuses, and I make $50,000 a year.

SMITH: Well, I understand that. I mean, sure. That's the very rough edge of the whole thing.

And let's face it, the amount of bonuses they're getting is a very small amount compared to that paid out to Merrill Lynch, which is $3.6 billion. This is only $165 million, by contrast. And it doesn't really go to very, very top people so much, as to the ones at the middle or upper middle part of the place.

But you really do need to be able to accomplish the government's principal objective in this case, which is to get its money back.

ZAKARIA: In other words, to have a strong AIG. So, if you own an insurance company -- and we as taxpayers all own it -- you're saying we're better off with a good insurance company.

SMITH: If we run everybody out and replace them with postal workers, we're going end up with a lot less money than we would if we kept the good guys in there to run it. You may not like the good guys, but that's their job, to get our money back.

ZAKARIA: Henry, you were at Merrill Lynch. You got big bonuses. What do you think of this whole thing?

HENRY BLODGET, PRESIDENT, CHERRY HILL RESEARCH: Obviously, the people on Wall Street have gotten big bonuses for a long time, and there's a lot to say for that. I think the thing that has changed everything here, though, is that it's taxpayer money.

And to your point, this is a company that would be worth zero, and nobody would be getting a bonus. And I think part of it is packaging. I can't believe that AIG's CEO, Edward Liddy, allowed these bonuses to go forward without actually going in and renegotiating them and saying, look, in this current environment we simply cannot have a bonus awarded for retention, especially to people who have left.

So, we're going to make it a salary. We're going to be very clear about what that salary is. It's not going to be an incredibly low level, but it certainly can't be what it would be in a normal environment. And we have to understand that people are watching incredibly closely, and this will justifiably outrage everybody.

ZAKARIA: Megan, I think of you as a libertarian from your blog. Should the government be deciding what bonuses people are getting?

MEGAN MCARDLE, ASSOCIATE EDITOR AND ECONOMICS BLOGGER, ATLANTIC MONTHLY: The outrage may be completely counterproductive. But on the other hand, it's totally valid. They are getting taxpayer money, and it is totally valid to feel like I shouldn't be paying some guy who got me into trouble, forced me to bail his company out, give him another $3 million.

On Henry's site, yesterday there was someone who posted a letter from an investment banker who pointed out that these guys hate their jobs. It's not a fun time to be in that position. And so, you may really need to pay the money to retain them.

Maybe the moral outrage is worth -- expressing our moral outrage is worth the price that we're going to pay if AIG gets into trouble. And that's a political decision. It's not really an economic decision.

ZAKARIA: You know, Roy, if Jon Stewart says on his show, when somebody talked about -- kind of made a somewhat similar argument to you where he said, "So, wait. We're trying to give the top 10 percent of the people at AIG these big bonuses. But aren't they the people who got us into this mess in the first place?"

And people feel that way about the Merrill Lynch -- you know, wait a minute. These are the guys who ruined, who brought the international finance system to the brink of disaster. And we're saying they're indispensable, and we have to pay them big bonuses?

SMITH: Yes. Pretty much, that's what we're saying.

(LAUGHTER)

I'm not saying that they should receive glorious treatment for this. All I'm saying is, we need them to be able to resolve it. And to throw them all away, which you might be inclined to do, giving them nothing isn't going to help us retrieve the money that the government has invested in there and we want to get back.

ZAKARIA: Henry, does this change the way bonuses are going to be given on Wall Street? I mean, is this some kind of a tipping point?

BLODGET: I think for a while. I think, as Roy was suggesting earlier, Wall Street goes through these massive cycles. And every time we have a complete crash like this, as we had after 1929, and after the '60s and so forth, this idea that Wall Street as we know it is dead, it's never coming back, and so forth.

Actually what's happening is, right now, a new Wall Street is growing up among the ashes. Lots of those folks are going to be paid very well, and they will be paid much better when the economy comes back, which it will eventually. And eventually you will have a whole new Wall Street caste system that comes up. And I suspect bonuses will be a big part of that, but not for a couple of years.

I think people have finally learned, given the outrage, that you've got to be awful careful how you award these.

ZAKARIA: Megan, you live in Washington. Are we going to see a new kind of regulatory regime? You know, is this -- Washington must be, at some level, enjoying getting its fingers in this extraordinary honey pot.

You know, they're ready to sit down and really get in there and start, you know, playing with all the levers and the pulleys. They want to do radical reform. There's a huge sentiment.

I mean, there's also a sentiment out on the street, on Main Street, that we've been taken for a ride, that people on Wall Street have been making outrageous sums of money for what turns out to have been not merely worthless, but actively harmful.

Now, obviously, that's completely exaggerated, in my opinion, and Wall Street does a lot of good things. But -- although I probably won't make any friends for saying that here.

But, you know, it doesn't really matter at this point what the underlying economic reality is. At this point what matters is the politically reality.

BLODGET: I think the real lesson from what's happened this entire week with AIG, where the government has wasted four days on these bonuses, where we've got every elected official arguing about what was disclosed, how outrageous it is, and now a new law, 90 percent tax on bonuses -- what a colossal waste of time. And...

ZAKARIA: And we've AIG how much money?

BLODGET: That's right, $170 billion...

ZAKARIA: Right. And this is literally...

SMITH: One-thousandth...

BLODGET: And to me...

ZAKARIA: ... one-thousandth of that money.

BLODGET: That's right. And not that people shouldn't be outraged. They should be.

But to me, the real lesson is, this is why the government should not be bailing out companies and getting into the business of operating them, or thinking it's supposed to be operating them...

ZAKARIA: Can it start... BLODGET: ... because it is a disaster.

ZAKARIA: All right. On that note, if you haven't -- if you felt that wasn't enough populist outrage on this panel, write to me. We'll try to fix it the next time.

We will be right back. Thank you all.

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ZAKARIA: This week, Forbes magazine put Bill Gates back on top of its famed billionaires list. I recently had a chance to sit down with Bill and Melinda Gates. They wanted to talk about their money -- not how they made it or how much of it they have, but how they are trying to change the world with it, and specifically change our educational system.

Steve Ballmer says, describing Microsoft's situation -- he says, we don't expect this to be a quick turnaround. We expect this to be things go down, then they reset, the economy shrinks.

In an environment like this, can innovation continue? Can productivity rates go up?

BILL GATES, CO-FOUNDER AND CO-CHAIRMAN, BILL AND MELINDA GATES FOUNDATION: Absolutely. The number of engineers and scientists who come to work is not going to be appreciably diminished. That is, the top 20 universities in the world will not shut down. The R&D labs of the big companies may tune at the margin.

But because they know that's their future, whether it's Microsoft or any of the other companies, they're going to keep inventing computer software, genetics, materials, new ways of doing energy.

And those are the things that really make me quite optimistic that the level of health and wealth will achieve new records as we go forward over the next 10 years.

ZAKARIA: Between the two of you, who is more optimistic?

(LAUGHTER)

M. GATES: I think it depends on what the issue is. But it's often, I would say, Bill. But I think we both play...

B. GATES: Yes, we're both pretty optimistic.

M. GATES: Very optimistic. And we try to play the counterbalance for each other sometimes.

One of us will get really excited about, you know, the U.S. education system. And then the other one will say, OK, but what about these factors? Or one of us will get really excited about a new vaccine. And we'll say, but isn't that going to take a little longer than we think?

So we balance each other, I think, in that way.

ZAKARIA: Let's talk about one of the things in your annual letter you talk about as the failures of the foundation -- education. There's no question that, for an advanced industrial economy like the United States, the only way we are going to be able to raise living standards for our citizens will be rising education levels for everyone, their ability to complete high school, probably even go beyond.

And yet, you say that it's much -- it has proved much harder than you thought. What's the fundamental problem with reforming the U.S. educational system?

B. GATES: Well, education is a personnel system. And today you've got school boards and unions. You don't have much measurement of what's effective. You have people disagreeing over whether measurement is good or what you're valuing. And so, it's not a system that's been learning and improving.

Getting everybody a good education in the U.S. is both very important, but it may be the toughest goal that the foundation has taken on, even tougher than the 20 infectious diseases.

ZAKARIA: But that sounds impossible. I mean, this is the richest country in the world. We spend more per capita than most advanced European countries. You're going to spend a ton of money on it.

Why is it so difficult?

M. GATES: Well, I think because we haven't changed the system in so long, nobody has really looked at the system and said, what do you need to do to bring it into the information age?

We're still teaching kids for the industrialized age. And we haven't started to say how do you align high school curriculum with what's needed in college?

Let's just assume as a nation, all kids need to go to college. They need to complete high school and be ready for college, if they're going to enter society with great jobs.

And because today we even -- some people think, well, maybe we don't need to send some kids to college. But you've got to align the curriculum so that the kids are learning in high school what they need to learn to get in college, what they need to learn to get good jobs. So we've got to rethink the system.

And then, as Bill says, we've got to go back and look at, what does it mean to have an effective teacher? We all know what they look like. We all had some of them in school. We try to get our kids with the best teachers.

But what does it really mean when you're trying to educate as many kids as we are in the U.S. education system, 65 million in the public schools from K through 12?

And so, how do you get those teachers so they get great training, they get coaching, they get mentoring, they're not working just in their classroom, they're working across a set of teachers or a set of curriculums, the science teacher is hooked up with the math teacher?

We just haven't systematically looked at it as a nation and said, how do we bring it forward? And I think we've got to do that.

ZAKARIA: And how do you get -- as a systemic issue, how do you draw this kind of talent into the teaching pool?

Because what has happened in the United States, and in many other advanced industrial countries, was you had this golden age of great teachers, which were highly educated women who were, for both formal and informal reasons, barred from entering the work force, or from really succeeding in it. So they ended up becoming teachers.

And that's over with. And so you don't have that possibility.

How do you get them? Lou Gerstner says we should be paying teachers $100,000. Is that the answer? I mean, how do you get really talented people?

When I read that part of your report, I thought, the problem with this is, this is not a systemic fix. How do you make sure you get a good teacher?

B. GATES: Well, I don't think just raising the salary is the key thing. We've got to be better at transferring skills.

There are some things in the compensation system that are very strange. A lot of the best teachers only stay for a short period. And they're actually being paid very little, because they don't get the master's bonus, and they don't vest into the pension.

And the big payments for teachers come when they get those things. So a minority are being paid much better than another group.

So it's keeping the good -- identifying the good ones, identifying their practice, and raising the average capability. That's important.

ZAKARIA: Now, if this doesn't happen -- I mean, if you don't have fairly dramatic changes in the educational system -- can the United States continue to be the most advanced industrial country in the world with this enormously high per capita GDP, with technological ingenuity?

B. GATES: Well, the whole world would suffer if the U.S. isn't at the cutting edge and having these educated graduates who drive the world into new areas like biology and information technology.

So, the world would innovate at a lesser rate. The U.S.'s position as being such a rich country would be moderated.

Now, you know, only over a 20-year period does that start to have a very substantial effect. But this is the biggest issue for the future of the country.

ZAKARIA: Do you think there will be another series of innovations in IT, as there were over the last 20 years, that can produce productivity growth in the United States? Or should we be looking other places, energy technology, things like -- has the IT revolution kind of worked its way through the system?

B. GATES: Absolutely not. The chip miracle that was part of that continues.

The ability to navigate data, understand data, 3D viewing, seeing interacting with speech -- the whole way you looked at data in the workplace and the way you collaborate -- telepresence, data navigation -- we're on the verge of some huge breakthroughs. And the research at Microsoft and many other companies are going to bring that forward.

Now, materials science advances, energy advances, those are complimentary things, and we need all of those. And the science is making progress in every case.

I know the Microsoft one in particular, because that's why the R&D budget is so big there. And many of these things have been in the lab for five years now, and they're just starting to make their way into the marketplace.

ZAKARIA: On that optimistic note, Bill Gates, Melinda Gates, thank you so much.

M. GATES: Thank you.

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ZAKARIA: Now for our feature, "What In The World?" It's the week's biggest international outrage, gaff or amazing act of statesmanship -- anything that catches my eye. And this wanted poster definitely did.

This head of the Sinaloa Cartel is considered Mexico's most wanted criminal. The U.S. government wants him, too, and has offered a $5 million reward for his capture.

And Forbes magazine wants him for an interview, because he's made their annual list of the world's billionaires.

That's right. While you watched your 401(k) turn to dust, things were looking up for the drug runners of the world.

Unfortunately for Forbes, Loera isn't talking. He's been keeping a bit of a low profile.

Here's what I would say to Forbes. Whatever financial information they have on Mr. Loera should be sent immediately to the police or other authorities, not released on a Forbes list. We don't need to celebrate drug runners, we need to put them in jail.

Now, there will be no question of the week this week. Instead, I want to put all of your great minds to a different challenge. We're calling it the "The Fareed Challenge." It's a quiz on our Web site, cnn.com/gps. It has questions that will test if you were listening closely enough during the show.

It's great fun. Please try your hand at it.

Now, last week's question.

I asked you, do you think that the groups that lobby on behalf of Israel have too much influence? Or do you think this is a bogus, even scurrilous charge?

Last week, you recall, my guest was Charles Freeman, who had just withdrawn his nomination for a top intelligence post, blaming what he called the "Israel lobby."

Many of our viewers took exception to his reasoning, and even to the term "Israel lobby." But the question was raised by the interview, so I wanted to get your views.

We received more e-mails on this issue than any other we've addressed. And a sizable majority of our viewers said that, yes, the groups who lobby on behalf of Israel wield too much power.

But those who believe these groups do not have undue influence were particularly passionate in their feeling, that these lobbyists are no more powerful than, say, the Cuban lobby or the NRA. And many felt that even asking the question raises the specter of anti-Jewish sentiment.

In my interview with Charles Freeman, he stated that one particular group, the Zionist Organization of America, had been part of an attempt to bring him down.

(BEGIN VIDEO CLIP)

CHARLES FREEMAN, FORMER U.S. AMBASSADOR TO SAUDI ARABIA: Of course, they do not admit, but it is a fact, that they engaged in a truly libelous campaign of selective misquotation and distortion.

(END VIDEO CLIP)

ZAKARIA: The ZOA responded to the charges this way.

"Our research did not extend beyond the use of the internet, where our alleged 'selective misquotations' were amply provided by Freeman's own speeches.... The only things that 'libel' Freeman's reputation are his own vitriolic views."

Now, as always, I'd like to recommend a book. It's called "Imagining India," by Nandan Nilekani. Nilekani is one of the most successful CEOs in India, and he lays out how India can become a huge economic and political power on the global stage. It's a fascinating book, very well written, worth reading.

And don't forget to check out our Web site, cnn.com/gps, for extra Web-only interviews, highlights from the program, our weekly podcast, and our current events quiz. And you can e-mail me at fareedzakariagps@cnn.com.